Page 406 - SAIT Compendium 2016 Volume2

IN 33 (4) Income Tax acT: InTeRPReTaTIon noTes IN 33 (4)
Although it is accepted that any period of trading during the current year will meet the ‘trade’ requirement, a company that purports to trade for a few days in the year of assessment for the purpose of keeping its assessed loss alive will have to prove that such activity was genuine and not a tax avoidance scheme under section 103(2).
4.1.6 The ‘active step’ requirement
Trading involves more than a mere intention to trade (see SA Bazaars case cited above). In ITC 777* it was held that the mere intention to let property does not constitute the carrying on of a trade. In ITC 1476 Kirk-Cohen J stated the following:† ‘In my view the carrying on of a trade involves an active step – something far more than merely watching over existing
investments which are not, and are not intended or expected to be, income producing during the year in question.’
The active step must comprise more than the mere laying of plans. In this regard Eksteen AJ stated the following in
the Contour case:‡
‘There is, however, . . . a vast difference between the mere laying of plans for the . . . future, on the one hand, and the
commencement of preparatory activities for a future venture, on the other . . ..’
The reference to preparatory activities raises the question whether the preproduction phase of a business constitutes
the carrying on of a trade. This issue is explored below.
4.1.7 When does trade commence?
Expenditure incurred before the commencement of and in preparation for carrying on a trade is now provided for in section 11A (see 4.1.8).§ Despite section 11A, the date when trade commences is important because in some cases it can take several years before a company is in a position to earn income. If the activities in the current year are preliminary to the commencement of trade, the company stands to lose any pre-existing balance of assessed loss. This could be an issue with the termination by a company of one business while preparing to start another. The date when trade commences is also important because expenditure incurred after the commencement of trade is not ring-fenced under section 11A. There is very little guidance in South African case law on when trade commences.
In the United States of America (USA) there have been quite a few cases dealing with when a business commences in the context of section 162(a) of the Internal Revenue Code which allows a deduction for –
‘all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business’.
The only consistent principle to be extracted from these cases is that the question must be decided on the facts and circumstances of the particular case. One of the cases most often cited in the USA when dealing with start-up costs is that of Richmond Television Corp. v Commissioner,¶ The appellant was one of a number of companies competing for a television licence. It sought to deduct the cost of training employees before the licence was granted. The court began its discussion by stating that –**
‘the issue therefore is at what point of time did its business begin, and whether at this doubtful, prefatory stage it was carrying on a business’.
After reviewing various cases the court concluded as follows:††
‘The uniform teaching of these several cases is that, even though a taxpayer has made a rm decision to enter into business and over a considerable period of time spent money in preparation for entering that business, he still has not ‘engaged in carrying on any trade or business’ within the intendment of section 162(a) until such time as the business has begun to function as a going concern and performed those activities for which it was organized.’
A similar result prevailed in Madison Gas and Electric Co. v Commissioner.‡‡ In that case a utility that had formed a joint venture to construct a nuclear plant could not deduct employee training expenses paid until actual business operations commenced. The expenses were held to be pre-operational and had to be capitalised.
However, the USA courts have not always insisted that a company have opened its doors for business before it can be said to be carrying on business. In United States v Manor Care Inc§§ deductions were sought for pre-opening expenses for new nursing homes, before licences were received. The court distinguished the case from the Richmond Television case cited above on the grounds that the company was virtually assured of obtaining its licence if certain objective regulatory standards were met. The expenses were normal operating expenses and produced bene ts in the same taxable year, whilst in the Richmond Television case the expenses were incurred once-off over several years.
The court cited the following passage from a USA Regulation with approval:¶¶
‘Ordinarily, a corporation begins business when it starts the business operations for which it was organized. * * * If the activities of the corporation have advanced to the extent necessary to establish the nature of its business operations, however, it will be deemed to have begun business. For example, the acquisition of operating assets which are necessary to the type of business contemplated may constitute the beginning of business.’
In Brotherman v United States*** a partner in a cable television business was held to be carrying on business as he had acquired the necessary equipment even though the required licence had not at that stage been obtained. In Blitzer v United States††† a partner in a low income housing project was allowed to deduct an administration fee before construction
* (1953) 19 SATC 320 (t).
† (1989) 52 SATC 141 (t) at 148
‡ Above at 456.
§ See Interpretation Note No. 51 (Issue 3) dated 22 July 2014 ‘Pre-trade Expenditure and Losses’.
¶ 345 F.2d 901 (4th Cir. 1965).
** At 905.
†† At 907.
‡‡ 633 F.2d 512 (7th Cir. 1980).
§§ 490 F. Supp. 355; 1980 U.S. Dist. LEXIS 9143; 80-2 U.S. Tax Cas. (CCH) P9547; 46 A.F.T.R.2d (RIA) 5331. ¶¶ At 362.
*** 6 Cl. Ct. 407; 84-2 U.S. Tax Cas. (CCH) P9846; 54 A.F.T.R.2d (RIA) 6179; 1984 U.S. Cl. Ct. LEXIS 1286. ††† 684 F.2d 874 (Ct. Cl. 1982).
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